Is This the Start of a Major New Uptrend or a Bull Trap?
Jerome Powell could upset the party Thursday afternoon if he voices concerns about growing inflationary pressures.
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Following red wave election results, stocks exploded higher on Wednesday. The Wall Street Journal is reporting that “Wall Street Salivates Over a New Trump Boom,” and market players are actively searching for stocks and themes that will benefit from the sweeping changes that are soon to occur in Washington.
The technical action on Wednesday was a classic breakout, with the major indexes breaking to new all-time highs on increased volume. Most notable was the Russell 2000 small-cap index IWM, which jumped 5.8% and has now reached its highest close since late 2021. Smaller caps tend to lead when speculative interest is high, and market participants are focused on finding individual stocks that are undiscovered and lagging the indexes.
Despite the large move in the indexes, the internal action was a little weak, with breadth not even reaching two-to-one levels. Upside volume was also light, but there were 2,100 new 12-month highs due to the powerful move in small-cap names.
The issue now is whether the market can build on this strong momentum or if it will be a trap for salivating bulls that are anticipating a steady run higher as positive seasonality kicks in and hopes build for a Trump economic boom.
One issue that could easily upset the apple cart is interest rates. While stocks were screaming higher on Wednesday, bonds TLT were selling off, and interest rates were moving to their highest levels since May. The problem is that if Trump really is going to trigger a new era of economic growth, it will create inflationary pressures. Growth increases the demand for capital, and demand for capital causes interest rates to rise.
So far, the market has not been concerned about the steady decline in bonds, which started in September when the Fed announced a half-point rate cut. Fed Fund Futures indicate a 99% chance that a quarter-point cut will be announced at the Fed meeting on Thursday afternoon, but the chances of a cut at the next meeting on December 18 have been dropping, and the odds are now at 71%.
The market will be intensely focused on Fed Chair Jerome Powell's press conference Thursday, which will follow the FOMC interest rate announcement. There is a risk that Powell will start to indicate a less dovish posture due to the increased expectations of economic growth.
A more hawkish Fed will not necessarily kill the market uptrend. For the last several months, stocks have held up well even though interest rates have risen because investors believe that higher growth will offset some of the negative implications of higher rates.
What we need to watch from here is the ability of the market to shrug off signs of increased inflation. If momentum slows and dips, buyers will grow nervous that this breakout could turn into a bull trap. For now, the bulls are large and in charge, Powell could disrupt the party if he starts to voice some worries about inflationary pressures.
At the time of publication, Rev Shark had no positions in any securities mentioned.
